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Urgency in ABCP Grips Europe: Will the European ABS market learn from Northern Rock?
Asset Securitization Report--SourceMedia (September 24, 2007)
The Information Management Network couldn't have picked a more opportune time to host its inaugural Global ABCP and SIV's Summit, which was held last week. Against the backdrop of beautiful Paris, a roomful of industry players had some ugly matters to discuss.
During the one-and-a-half-day seminar, banks both accused and excused rating agencies for the flight of investors from ABS and related products. Rating agencies blamed the press for the "confusion," as a vice president of Moody's Investors Service put it. The press blamed spiteful investors who were going on strike as payback for maltreatment from investment banks. Short-term investors who started entering the long-term markets were blamed. SIV investors were called ignorant and overdependent on rating agencies. SIV managers and their lack of transparency were also called out. Conspiracy theorists blamed Basel II.
Everyone suffered, in short, and no underlying reason for the collapse in ABS business in Europe could be specified. Walt Shulits, a vice president at wealth manager Eaton Vance, admitted that his firm has only a few SIVs and does not really invest in ABCP. Shulits said it was "ludicrous" to say the rating agencies could have avoided this. "No one has a crystal ball," he said.
And the three rating agencies couldn't agree more. Andrea Quirk, a director at Standard & Poor's, noted that of 315 rated programs with exposure to the U.S. residential mortgage market, only 11 had rating actions taken. SIVs have worked as they are supposed to, because "the assets themselves are mighty good," said Paul Kerlogue, a vice president at Moody's. Kerlogue praised SIV managers as well for withstanding immense pressures over the past six to eight weeks.
In truth, participants at the conference were less concerned with how exactly the market got into its mess and more interested in what the future may hold. Kerlogue said that one may as well flip a coin to determine the future of SIVs. A potential investor said afterward that he remained unconvinced that SIVs won't see widespread defaults, and he was uninspired by other ABS products. As one speaker put it, "We aren't seeing a flight to quality; we are seeing a flight to products other than structured finance."
Peter Vinella, a panelist at one of the sessions who is now president and CEO of Wilmington Trust Conduit Services, said he had never seen such panic gripping the market - and Vinella has been in the hot seat before. In 1994, he testified before Congress on his views of the credit derivatives market. In his testimony, Vinella stated that strict regulations could be applied to the market, but that they wouldn't have any teeth. "You can't ban derivatives trading in the global market, or stop an American bank from doing it," he said at the time.
In Paris last week, Vinella spoke against new regulations to try to control the downward spiral gripping the structured finance markets - in opposition to the increased, tighter guidelines several players believe could quell future disruptions. Omar Olaf Bolli, head of asset-backed finance at Nord LB, predicted a slow and steady return to normal levels, but not before 2008. Bolli's opinion proved to be the most popular.
Bolli didn't mince words when he said he believes there will be a return to more traditional forms of credit fundamentals. He said investors will remain confident in investing in 30- to 35-day paper in the U.S., and in 30-day paper in Europe, and that more plain-vanilla programs will trade at the right maturities. In approximately half a year, ABCP spreads should return to one or two points on either side of Libor, he said, and that pricing levels will stay in line with those of more established, multiseller conduit structures - in other words, the way he told senior management that ABCP should be run.
"Old-timers like us used to be described as dinosaurs," Bolli told the younger crowd. "But this time around, the dinosaurs don't become extinct."
Gerwin Sharmann, executive director of ABN Amro's conduit management team, added that the crisis may not be finished yet, but that his bank had played conservatively and was not suffering as a result. In his 15 years of experience, he had never seen "such a lack of confidence in such a broad market," but said those who stick to their guns would come out strong. ABN Amro had ensured 100% liquidity, Sharmann said, underwrote investments and did the research itself. As a result, the bank is not seeing a decline in its primary bond market and no secondary collapse.
Markus Herrmann, head of global ABS research and strategy at HSBC, believes that a turnaround is expected but that the "catalyst is still out there to be found."
Considering the urgency in the market, attendance for the seminar seemed suspiciously low to some. As one treasurer of an Austrian bank expressed his disappointment in the lack of SIV managers at the IMN gathering, he dismissed the notion that they were simply too busy to come. "That is just a good excuse," he said. "Most SIV managers just don't want to be here right now."
The Difference a Day Makes
Those who may have walked away from the Paris forum with a feeling that perhaps players had become naively optimistic at the market's ability to correct itself had only to look at the quick turnaround that British mortgage lender Northern Rock saw over a span of five days.
On the Friday before the Paris gathering, the Bank of England stepped in and provided an uncapped facility to Northern Rock, which will fund itself either by borrowing on a secured basis from the Bank of England or by entering into a repurchase agreement with the central bank at an interest-rate premium. A repo would include RMBS backed by prime residential mortgage assets.
"The chancellor's decision to authorize was made on the basis of recommendations by the governor of the Bank of England and the chairman of the [Financial Services Authority]," said Sarah Barton, primary analyst at Morgan Stanley. "The FSA judged that Northern Rock was solvent, exceeded the required regulatory capital and has a good-quality loan book. The Bank of England also mentioned that in its role of lender of last resort,' it was ready to provide facilities under similar circumstances to other institutions facing short-term liquidity difficulties."
Societe Generale analysts said that bonds are trading as wide as 75 basis points for five-year triple-A paper. Fitch Ratings on Friday downgraded Northern Rock's long-term issuer default rating (IDR) to A' from A+' and its individual rating to B'/C' from A'/B' and placed them on Rating Watch Negative (RWN). "A further downgrade of Northern Rock's senior ratings could impact its ability to substitute mortgages, and hence cause extension risk," SocGen analysts said.
By the Wednesday after the conference, the long lines at Northern Rock had already disappeared. With no subprime holdings but massive subprime exposure, the bank seemed to be in better shape. Its shares closed 8.2% higher on Tuesday. Shares also rose for other banks that had been sucked into the swirl: Alliance & Leicester, Bradford & Bingley and Paragon.
As far as the public is concerned, the crisis may not be over, but it is in a holding pattern for now. "Northern Rock does not have material exposure to the U.S. subprime sector, and its business model had been extremely successful over many years," said Ian Linnell, managing director and head of Fitch Ratings EMEA financial institutions group. "However, unprecedented disruption in the global capital markets resulted in it requiring liquidity facilities with its central bank. [That] resulted in a classic run on deposits when this was incorrectly viewed as a bailout by the Bank of England. As a result, what was a funding issue for Northern Rock quickly accelerated into a full-blown liquidity crisis."
Fitch expected Northern Rock's funding to stabilize as a result of the government's unprecedented announcement that arrangements would be put in place to guarantee all existing deposits in Northern Rock during the current period of market instability.
Over the longer term, Fitch said the most likely outcome is that Northern Rock will be taken over by a larger institution, although its attraction to a domestic bidder may be limited. "We expect a takeover of the bank will occur by a larger sponsor, providing stability to the system," SocGen analysts said. "Several approaches have already occurred, and the Bank of England has stated that any purchaser would continue to benefit from the guaranteed liquidity facility it has provided."
According to Jean-David Cirotteau, a securitization analyst at SocGen, the recent developments of the U.S. ABCP market are showing signs of slight improvement. "The latest figures from the Fed reported a slowdown in the decrease of U.S. ABCP outstanding, now amounting to slightly below $945 billion," Cirotteau said. "Besides, there was a slight increase in activity, with important credit tiering from one conduit to the other. This is positive news overall." ABS investors, however, still mantained a complete lack of confidence. As market liquidity returns, funding continues to be an issue for a number of players.
One investor from the petrochemical industry attending the Paris gathering said that six months ago, his firm decided to add some prime RMBS to its portfolio. He told his bank that his company wanted some long-term investments. After all, the oil business is booming, and producers are not exactly in the position of having a lack of cash.
The bank suggested Granite, Northern Rock's vehicle. "It didn't seem right at the time, so we passed, and feel lucky not to have that paper on the books in light of recent developments," he said.
HSBC's Herrmann told IMN attendees that assets are currently at their cheapest in a decade, that great opportunities are out there and that the market won't ignore the opportunities much longer. "I'm not convinced," responded the investor. "And we don't want to be the first ones back in."
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